Drug Sales, Store Closures, and Walgreen’s Second Quarter

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Source: Getty Images

It’s not all sunshine and happiness for Walgreen Co. (NYSE:WAG), but the drugstore operator did seem to wake up on the right side of the bed on Tuesday morning. Shares climbed as much as 3 percent in early trading after the company reported decent second-quarter earnings — let’s call them mixed, leaning toward optimistic.

Second-quarter sales increased 5.1 percent on the year to $19.6 billion, effectively in line with the mean analyst estimate. For the first half of the year, sales were up 5.5 percent at $37.9 billion. Comparable store sales increased 4.3 percent in the second quarter, but customer traffic declined 1.4 percent. A 3.4 percent increase in basket size is consistent with the idea that although there may be less foot traffic through Walgreen stores, those customers are purchasing more. Part of the catalyst for bigger baskets is the successful ongoing rollout of the Balance Rewards loyalty program, which had 100 million enrollees and 80 million active members in February.

With Walgreen, it’s important to understand that more than half of revenue (62.2 percent in the second quarter) comes from the sale of prescription medicine, so many investors focus primarily on this segment. Strength in second-quarter prescription sales helped offset some weakness elsewhere, as total medicine sales increased 7 percent on the year while comparable-store prescription sales increased 5.8 percent. Walgreen filled a total of 214 million prescriptions in the second quarter, and the company claimed a 19 percent share of the prescription retail market, up 20 basis points on the year.

“Walgreens also saw strong growth in prescriptions filled for Medicare Part D patients, which increased 16 percent in the second quarter compared with last year’s quarter, while the company’s Part D market share increased 0.8 percentage point in February compared with the same month a year ago,” the company reported.

Where the top line looked pretty good, the bottom line looked a little beat up. GAAP total gross profit increased 0.8 percent, but gross profit margin contracted 1.3 percentage points to 28.8 percent and adjusted gross profit increased just 0.4 percent.

“Pharmacy gross profit dollars were primarily impacted by the shift in the generic drug wave from a peak in the prior year to a trough in the first half of fiscal 2014,” Walgreen said in its earnings release. “A less severe flu season in this year’s second quarter compared with a year ago also negatively impacted pharmacy gross profit dollar growth.” Walgreen reported adjusted earnings of 91 cents per diluted share, below the mean analyst estimate of 93 cents per share.

Walgreen has grown rapidly over the past few years — shares are up more than 87 percent in the last two years — and it appears to be time to trim the fat. Walgreen President and CEO Greg Wasson announced, “While we seize the opportunity for store growth as the population ages and consumers look to community pharmacy for their health care needs, we also continue to focus on optimizing our assets and organization to position Walgreens for our future as a global company.”

This means shuttering 76 drugstores in the second half of 2014, although Walgreen still expects to open net new stores of between 55 and 75. The company currently operates 8,681 locations spread all across the U.S. Beginning fiscal 2015, this store optimization is expected to provide an EBIT windfall of between 2 and 3 cents per share and charges of between $240 million and $280 million in the third and fourth quarters of 2014.

Walgreen stock is up more than 13 percent this year to date, outperforming competitors like CVS Caremark (NYSE:CVS), which is up 5.6 percent year to date, and Express Scripts (NASDAQ:ESRX), which is up 8.4 percent year to date. Both companies compete with Walgreen in the all-important prescription market. Although they have both faced headwinds, the companies have also both demonstrated that they can work though them.

CVS, for one, posted strong fiscal fourth-quarter results in February that came in above expectations. Net revenues increased 4.6 percent to a record $32.8 billion, beating the mean analyst estimate of $32.67 billion. Adjusted earnings increased 15.8 percent to $1.12 per share, beating the mean analyst estimate by a penny. It’s worth pointing out that while earnings beat, the comparison was particularly favorable.

CVS Caremark took a charge of 17 cents per share for debt extinguishment in the fourth quarter of 2012. Excluding this charge from the comparison, adjusted earnings are down 1.9 percent. Unadjusted (GAAP) earnings increased 16.9 percent on the year to $1.05 per share. Revenue gains were driven by strong performance in the company’s pharmacy segment.

Here is Walgreen’s second-quarter earnings presentation, as prepared by the company.

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